Equity markets continued to appreciate during the first quarter with the FTSE JSE All Share Index returning 5.9%. International equites also delivered acceptable real returns with the MSCI All Country Index returning 1.8% in Dollars. On the local front, the Industrial (+6.0%) and Financial sectors (+10.6%) once again surged ahead. In contrast, the Resources sector (-0.3%) continued to be plagued by softer commodity prices.
While the majority of asset classes have for some time now delivered phenomenal real returns, it may be an appropriate time to consider the famous proverb “this too shall pass". Resources will at some point rebound. Value Managers will once again have a period of significant outperformance. Equities will not go up in a straight line every quarter.
Since 2009, the Resource sector’s relative underperformance has been dramatic. The graph below shows the cumulative performance of these three broad sectors over the last six year. Astonishingly, Financials have appreciated by 25.8% per annum, Industrials by 30.8% per annum whilst Resources appreciated way below inflation. Said differently, if you had invested R100 in the Industrial sector over this period, it would be worth R500! An investment in the Resources sector would be worth R125.
Relative Performance of the Resource, Industrial and Financial sectors
Source: Data compiled by Morningstar
Similarly, value investing has completely fallen out of favour following several years of underperformance. Value investors look for companies on cheap valuation metrics, typically low multiples of their profits or assets, for reasons which are not justified over the longer term. Many respectable asset management firms have been under significant pressure trying to defend their investment style. Over the last 5 years the MSCI SA Value Index (measures the returns of companies that have been classified as value) has delivered just over half the returns of the MSCI SA Growth Index. To a large extent, this implies that local Value Managers have not suddenly become poor managers. More cyclical headwinds have been affecting their performance. Academic evidence is supportive of value investing over the long term. To benefit, patience is required.
In addition, many market commentators feel that the South African stock market looks expensive. They point to the current Price to Earnings ratio of the market as evidence and highlight the fact that the ratio is significantly higher than its longer term average. Historically, when the Price to Earnings ratio is high, returns over the next few years tend to be muted.
Price to Earnings Ratio of the FTSE JSE All Share Index
Source: Data compiled by Inet
We believe that our clients should have a diversified portfolio across a range of asset classes, styles and sectors. There will be a time when holding too much equity, too little exposure to the Resources sector and no exposure to Value Managers will be detrimental. “This too shall pass”.
Author David Bacher Corion Capital